Market Meltdown Hits NYC Commercial Real Estate

Companies Advised to Be Patient and Prudent—and Not Panic

The meltdown of capital markets is beginning to shake up the commercial real estate market in Manhattan.  While some areas of the country are more vulnerable than others—especially metro centers like New York City with large financial institutions—all sectors of the economy are taking a hit. And while the bailout may start to provide relief as the government purchases troubled loans, this process will likely take an extended time, and the prevailing feeling among corporate real estate executives will continue to be uncertainty.     

How bad is it?  That is debatable, but certain dynamics are clear.

With some companies shutting down and many others forced to cut back, the unemployment rate is going up.  Unemployment in Manhattan is rising and job layoffs in companies in the financial services sector will take their toll.  Layoffs will result in space disposition, and we are already seeing large amounts of sublease space coming online.  Within the last couple of months, several large blocks (>100,000 square feet) have been listed in Manhattan, and this may be the tip of the iceberg.

This will lead to rising vacancy levels, negative absorption, and declining rental rates.  In short, we have the signs of a prolonged recession—or worse, if the bailout doesn’t work.

Yet, despite this seemingly bleak forecast, most landlords are still projecting an air of confidence.  They say that the New York City vacancy rate remains one of the lowest in the country and rents remain the highest.  Statistics, they say, don’t lie, and landlords are hoping their tenants won’t question them.

The Real Pulse

The truth is that statistics are much better at recording the past than reflecting the present and forecasting the future.  In fact, conditions on the street today will not be reflected for one or two quarters.  But landlords and their brokers know the score: 

1. Velocity is down dramatically, and we expect this to continue through next year.
2. Companies are shedding more space, and we forecast that vacancy will climb an average of 2-4% over the next two quarters.
3. Asking rents are now down an average of 20% in the last quarter. Rents will likely continue to decline for another two quarters before the market levels off.
4. Venture capital investments have dropped substantially, and commercial mortgage-backed securities are completely stalled.
5. Sales in commercial real estate have declined about 90% this year, and limited trading is expected as long as financing remains hard to secure.
6. Limited new inventory is expected to come online, with fewer existing construction projects and virtually no new building anticipated. 

But before we push the panic button, let’s put this meltdown in perspective.  Yes, this may be the worst credit crisis since the Depression, but what’s happening now is in fact an inevitable market correction that has parallels to the subprime housing debacle.  In both the residential and commercial real estate markets, loans have been awarded for much more than the properties were worth, and now banks are trying to unload bad loans while there seems to be no buyers. 

Still, the mess in the commercial market is not nearly as pronounced as it’s been on the residential side.  In the typically stable commercial market, there is much less supply and many more income sources.  In general, landlords can still generate enough cash, and defaults are low, though values are declining and pressures are mounting for landlords and investors to maintain their assets.

The Silver Lining

So what is our advice to tenants during these unsettled times?  We are counseling them to be deliberate and strategic.  Indeed, companies can find a silver lining in today’s volatile economy if they do the following:

• Exercise greater control.  It’s now (or becoming) a tenants’ market, which gives companies more leverage in dealing with landlords who desperately want to hold onto credit-worthy tenants.  Tenants should keep this in mind as they consider negotiating new lease terms like expiration rights as well as new tenant improvements and additional concessions.  Companies with leases approaching expiration should determine what assets they want to hold onto and what they might dispose. Companies with longer-terms leases may want to consider disposing space, especially if they face job layoffs. And all companies should make sure that decisions on short vs. longer term leases are aligned with their business plan.   

• Protect the bottom line.  It’s now more critical than ever for companies to protect their assets and cut costs.  Real estate remains the second greatest corporate expense, following payroll, and the risks today are enormous.  In considering cost-saving measures, tenants should note that if they negotiate directly with landlords (as opposed to outsourcing to service providers), they may overpay by about 20%.  And they can save more by partnering with a tenant advisory firm that exclusively represents them, not landlords.

• Think strategically and long term.  Another way to save in the long run is to make modest upfront investments in strategic planning and project management.  By working with project managers, companies can reconfigure their space and improve productivity.  This is particularly important to companies that may need to downsize or “right-size.”

• Ask about conflicts of interest.  Landlords wary of their cash flow are now putting enormous pressure on brokers to close deals. This can be problematic to tenants when they consider that brokers from traditional firms (which represent tenants and landlords) cannot adequately serve two masters and avoid conflicts of interest.  Especially in this environment, tenants need to ensure that their broker is putting their interests first. 

The Changing Landscape

To be sure, tenant rep firms and traditional firms are colleagues that work together. But the tenant rep model is gaining traction during this time as companies realize how much is at stake. Increasingly, we encourage companies to apply due diligence in selecting a brokerage firm, considering variables such as the firm’s financial stability. In this light, the plummeting stock of some of the largest publicly traded real estate providers may be cause for concern.  Public companies are also beholden to the stockholders, not the tenant.

Another concern is that many real estate firms have recently merged in attempts to bolster their revenue. But what’s good for a brokerage’s bottom line may not be good for tenants, and companies may want to consider the advantages of partnering with non-biased, independent advisory firms.

In the final analysis, we are telling tenants that we feel their pain.  Their fears of the unknown are partly justified because no one knows exactly how the bailout will play out. But we do know that this is a time for patience and prudence, not panic. The meltdown is a reality, and we may now be witnessing just the tip of the iceberg.  But commercial real estate is built on a firm foundation, and we can take steps to weather the storm.

This entry was posted on November 26, 2008 at 2:35 pm and is filed under Articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or trackback from your own site.